Bets Against AIG BSC & LEH Are Not What Killed Them
And speaking of nuance:
Too many reporters still don’t seem to fully understand what killed Lehman, AIG, Bear, etc. Paragraphs like this in today’s NYTimes are simply wrong:
“Echoing the kind of trades that nearly toppled the American International Group, the increasingly popular insurance against the risk of a Greek default is making it harder for Athens to raise the money it needs to pay its bills, according to traders and money managers.
These contracts, known as credit-default swaps, effectively let banks and hedge funds wager on the financial equivalent of a four-alarm fire: a default by a company or, in the case of Greece, an entire country. If Greece reneges on its debts, traders who own these swaps stand to profit.”
No, those trades are not what “nearly toppled” AIG; rather, the company purposefully took on an inordinate amount of highly leveraged risk — 3 trillion dollars worth — with a massive concentration in housing and mortgage markets. Their models assumed that home prices were not going to falter, something demonstrably false had they done 15 minutes worth of research on it. Add to this the fact they failed to have any reserves on those ginormous trillion dollar bets. Further, the bulk of their most volative exposure was to rapacious counter-parties who out-maneuvered them at every turn.
These credit default swaps (CDS) were a bet on the deteriorating fundamentals of a company whose death was inevitable.
The CDS argument is a variation of the “Shorts are killing our company” nonsense that so many money-losing firms (Now, with accounting restatements!) hide behind.
Later in the piece, the Times captures the issue much better:
“A result, some traders say, is a vicious circle. As banks and others rush into these swaps, the cost of insuring Greece’s debt rises. Alarmed by that bearish signal, bond investors then shun Greek bonds, making it harder for the country to borrow. That, in turn, adds to the anxiety — and the whole thing starts over again.
On trading desks, there is fierce debate over what exactly is behind Greece’s recent troubles. Some traders say swaps have made the problem worse, while others say Greece’s deteriorating finances are to blame.”
That captures the subtlety better.
Lost in this argument is an understanding that ALL credit and banking is based upon a belief system: That the borrower is acting in good faith, that they remains credit worthy, and they have the means to service the debt.
The good faith and belief of their clients, trading partners and under-writers is a very fragile thing. That was something Dick Fuld of Lehman Brothers discovered way too late. It took a long time to fritter away 100 years of good will — it happened so slowly that he did not notice it. Perhaps if he saw that belief fading, he would not have rejected the firm saving billion dollar deal offered by Warren Buffett . . .
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Source:
Banks Bet Greece Defaults on Debt They Helped Hide
NELSON D. SCHWARTZ and ERIC DASH
NYT, February 24, 2010
http://www.nytimes.com/2010/02/25/business/global/25swaps.html
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February 25th, 2010 at 7:25 am
NYT:
February 25th, 2010 at 7:34 am
Any idea why Buffett was stepping in to save Goldman and Lehman when he himself had warned derivatives were a problem waiting to happen? Theoretically, he could’ve taken his pile of cash and launched his own financial house, had no exposure to bad debts and hired the best from among the rubble. Instead he chose to bailout bad actors, which isn’t capitalism.
February 25th, 2010 at 7:58 am
the facts are you cannot bear down financially sound companies, value investors jump would jump in hand and foot, it is there life blood
buffett, he loaned goldman money at mob rates, goldman while they have derivatives as a proportion hold less, and what they have is hedged, plus, gubment ties, which he also has, the failures of xyz bank is a godsend to those left standing, they get the clients, clients do not disapear, and they also get the product lines and less competition, it is why you hear too big too fail, they are factually bigger, much
February 25th, 2010 at 8:03 am
AIG, were fools with a triple AAA rating. They sold a pile (trillions of dollars qualifies as a pile) of insurance with no reserves all based on real estate always going up (who said trees don’t grow to the sky). A great way to make more piles of short term cash with lots of bonus cash for management, but not a good plan for long term company health. Systemic risk at its finest.
All of these companies, AIG, Goldman, Bear Stern, Lehman, Goldman etc. are like a cancer that has undergone metastasis so they are too big to operate on (as in cut out). So they have been given a lot of pain killers at tax payers expense with the “hope” that a miracle will happen and things will get better. We’ll see but I doubt it will work for long. We’re now dependent on a miracle, and miracles don’t happen often.
February 25th, 2010 at 8:03 am
Dick Fuld “learned way too late”??? Ridiculous.
What the hell was he doing in the top job if he didn’t already know what any first grade student knows?
He damned well knew his economics. His motives for persisting are far more nefarious than “learning too late”.
February 25th, 2010 at 8:34 am
Well, do tell! What were his motives?
February 25th, 2010 at 9:15 am
BR:
Answer my question: What was he doing in the top job if he didn’t know that “the company purposefully took on an inordinate amount of highly leveraged risk ?
February 25th, 2010 at 9:20 am
As for his motives, look to his compensation package over the previous 3 years for real motives. They took on highly leveraged risk to raise his compensation.
How hard is this stuff to figure out?
February 25th, 2010 at 9:31 am
Fuld is the guy that according to his testimony before Congress made a cool $600,000,000 in the six years right before his company went tits up. What a country.
February 25th, 2010 at 9:31 am
Which is why… the whole regulators game is:
IF you’re gonna need to intervene… intervene EARLY.
DONT do what Paulson/Bair did…. talk tough for 9-18 months… making the problem worse… and THEN have a crisis force your hand. Stupid and 10x costly.
February 25th, 2010 at 9:32 am
Whenever someone makes the “Look, shorts!” argument, I always ask – ‘What does the stock price have to do with the solvency of the company?’
February 25th, 2010 at 9:34 am
It seems like the desired end-state for all these nations is low rates in perpetuity.
Greece thinks its world would be all good if it could just borrow at 3.5% rather than 6.9%? This is completely delusional.
February 25th, 2010 at 9:39 am
How to stop another derivatives inferno by the by chairman of the Commodity Futures Trading Commission
http://www.ft.com/cms/s/0/3b52b642-217c-11df-830e-00144feab49a.html?ftcamp=rss&nclick_check=1
“Many of the financial institutions that kicked over the lantern in 2008 now oppose critical aspects of reform. This should be expected; after all, regulatory reform would mean big changes for the biggest banks. But Wall Street’s interests are not always the same as the public’s. Banks have a duty to their shareholders to maximise profits. In 2008, we watched them fail to manage their risks. It is now time to enact reform so that taxpayers no longer bear the price of Wall Street’s mistakes.”
This guy has a handle on what should be done. Read the article. It makes too much sense, writing trillions in insurance contracts without any reserves just doesn’t make sense. Especially since the entire world’s economy blew, and we still haven’t fixed the problem. What is so frustrating is that this problem was known long ago (read Buffet’s Annual reports from 2002). Why can’t it be fixed.
You have to ask is this country capable of fixing anything? Or as I said above maybe the tumor is just so large it can’t be operated on and the only out is a miracle fix.
February 25th, 2010 at 9:59 am
[...] From The Big Picture: Lost in this argument is an understanding that ALL credit and banking is based upon a belief system: That the borrower is acting in good faith, that they remains credit worthy, and they have the means to service the debt. [...]
February 25th, 2010 at 12:00 pm
One of the big mistakes that Lehman made was putting Erin Callan on a phone call with David Einhorn. Her performance was horrible, and to have a CFO who clearly was not in command of the facts was very destructive to any belief that the top-level management of Lehman a) understood their own book and b) was minding the store.
Fuld furthered this erosion in confidence by his own actions.
The one place where I quibble with you Barry is where you said it “…took a long time to fritter away 100 years of good will…”
I think, in hindsight, it took only about six months. From 2/2008 to 8/2008. In today’s market, after the collapse of Lehman, Bear, AIG, GM and Chrysler, I think that a company could destroy 100 years’ of confidence and goodwill in an even shorter time. Everyone’s BS detectors are set on “11″ and it would take only a couple of gaffes by senior management of any company now to utterly destroy goodwill.
February 25th, 2010 at 12:14 pm
A result, some traders say, is a vicious circle. As banks and others rush into these swaps, the cost of insuring Greece’s debt rises. Alarmed by that bearish signal, bond investors then shun Greek bonds, making it harder for the country to borrow. That, in turn, adds to the anxiety — and the whole thing starts over again.
I believe that is called price discovery is it not? It is something the RE market could use
Lost in this argument is an understanding that ALL credit and banking is based upon a belief system: That the borrower is acting in good faith, that they remains credit worthy, and they have the means to service the debt.
In the back alleys that kind of thing is called a confidence game. When the government is doing it, it is called good faith and credit. One gets you thrown in jail, another gets you into to the highest offices of the land on the flood of donations from these con men
February 25th, 2010 at 12:22 pm
A lot different than the 100% AIG got the next day.THANK YOU Hank!
Feb. 25 (Bloomberg) — Lehman Brothers Holdings Inc. will pay JPMorgan Chase & Co. $557 million in cash and let it keep $7.7 billion in collateral in a deal to settle some of the bank’s claims in Lehman’s bankruptcy case.
JPMorgan, the second-largest U.S. bank by assets, will transfer back to Lehman “illiquid securities” with a face value of $9 billion that it is also holding as collateral, according to a court filing yesterday in New York.
Is illiquid like worthless?
February 25th, 2010 at 12:24 pm
dear federal reserve and goldman sachs,
I know you’re doing your best, yet, in reality it’s that pesky thing called integrity and math that rules the day. Things like demogrpahics, real production, and profit too support debt. I’ve often quoted what is going on as “insane”, so, i’m very confident you see it also, and under a ton of stress and weight, I am sure you are doing your best. What I have yet too figure out is what you’re fear is? That we are all a bunch of pussies and can’t endure hardship? Or, that you worry you will lose control and or power?
In my infinite man on the street wisdom, I am sure it is a bit of both, for we all have similar fears in life.
As, I’m sure you’ve all talked about in backrooms and whispered breadth that things don’t add up or make sense. I truly hope one day you all realize the things you are doing at the end of the day really don’t, and the best path forward is a 12 step plan. Debt does not cure debt. Unless I am missing something it is quite possible I am the fool. The only difference here is I will bet on my own wisdom any day.
Hoped That Helped
Good Luck
PS-U can never stop the music in me. I sing a song of freedom in my heart, no matter where the river flows.
February 25th, 2010 at 12:25 pm
Man, I wish I could get Lehman to cut a little check like that to me…..”Hey, I don’t want it all, and I don’t want to change what they are doing, I just want a taste” (hat tip to the late Bernie Mac!)
February 25th, 2010 at 1:09 pm
[...] Short sellers didn’t kill Lehman Bros. and Bear Stearns. (Big Picture) [...]
February 25th, 2010 at 1:22 pm
Some of you here seem to think “Lehman failure” was rational, neccessary, or helpful. It was probably none of the three. But at least, not the first two. Whether it was “helpful” depends on your perspective (very helpful for speculators).
Dick Fuld was offered a large equity infusion by the Korean Soverign Bank just weeks before the Lehman bankruptcy. The issue was… the stock was at $24 and they offered it at $20. He couldnt stomach that. The Korean’s looked back on this at the 1-yr anniversary… and wish Dick Fuld had accepted as they would’ve done very well. Instead Barclays made out like a bandit (extracted $5-10B in value) and consultants, lawyers, and non-working employees have been paid billions. Other divisions have lost or left with $Bs in value. And frictional costs and uncertainty of “bankrupt Lehman” are good for no one. If fact, even AIG likely would’ve been unwinding into better markets had Lehman accepted the Korean offer.
Of course, if credit and equity markets hadnt bottomed so hard in Nov and Mar… speculators (like me) wouldnt have been able to make ~100% on risk capital out of the bottom. Volatility is certainly good for speculators. And it sets up the next big upswing.
February 25th, 2010 at 1:27 pm
[...] This is insanely wrong. [...]
February 25th, 2010 at 1:35 pm
BR:
Who wrote the CDS contracts on Greece? Word has it that it was the Greek banks. Who owns the Greek banks? Why, it’s the Too-Big-To-Fail banks of Europe, of course. So, these European banks effectively bought the CDS contracts from themselves. Therefor, if Greece defaults, who loses? Answer: Not the European banks because they will be bailed out by the European governments (i.e. European taxpayers). Therefore, this IS exactly like the Lehman/AIG/Goldman fiasco.
February 25th, 2010 at 3:18 pm
I read yesterday that it’s largely Greece’s EU partners who’ve bought the CDS contracts against Greece which has scared the underlying bond holders and thus driven up the Greek government’s cost of funding. France and Germany being the two largest creditors I believe.
Back to AIG. I think it’s fair to say that AIG never would have arrived at its enormous position in CDS contracts had credit default swaps not been exempted from regulation by the Commodities Futures Modernization Act of 2000. So 2000? That was still on Bill Clinton’s watch. Perhaps it was Greenspan (and guessable others) who convinced the Clinton administration that the CFMA was really a very good idea. “Sophisticated investors” and all that.
Proper regulation regarding CDSes would have involved reporting large trades as well as “outstanding interest” (your position) and a frequent, probably daily, basis. And there would have beeen limits to those positions.
February 25th, 2010 at 4:07 pm
BR, thanks for mentioning it… I about spilled my coffee reading the paper this morning. Article could be a reporter’s fault, but putting it front page takes an editor. The Onion had it about right on Greece, “Greece: 2500 years past its prime.”
February 25th, 2010 at 4:42 pm
[...] swaps didn’t destroy Lehman, Bear Stearns and almost topple AIG, Barry Ritholtz argues. Instead it was the “inordinate amount of highly leverage risk” that nearly crippled [...]
February 25th, 2010 at 7:57 pm
[...] blaming the shorts: Barry Ritholtz takes issues with those that still believe that short-sellers are to blame for killing AIG, Bear and Lehman. [...]